What is the Difference Between Cash Basis and Accrual Basis? - Chartered Accountants in Croydon

 Accrual accounting can have a significant impact on your company, so it's important to understand how and when to use it.

The cash basis of accounting is significantly easier and more uncomplicated than the accrual method.

The timing of when a company's revenue and expenses are incurred is dependent on the type of accounting system it uses.

Accounting on an accrual basis is a necessity for many types of businesses.

This article is geared toward business owners and professionals who have an interest in accounting software and best practises.

The cash basis of accounting requires that income and expenses be recorded only when cash is actually received or paid by an organisation. Accounting on an accrual basis involves tracking income and expenses at the time they are incurred, as opposed to tracking them at the time that money is actually exchanged hands (when an invoice is sent or a bill is received). Cash accounting is much more straightforward, but accrual accounting is necessary for some businesses and preferable for others who wish to take advantage of certain tax planning opportunities.

Because of the distinctions between cash accounting and accrual accounting, it's possible that one of these approaches is better suited to your company than the other. Fortunately, the majority of accounting software makes it simple to monitor the financial state of your company using either the cash basis or the accrual method. Bear in mind, however, that in order to accurately track both your income and your expenses, you need to first choose a method for doing so, and then stick with that method consistently.

Accounting based on cash rather than accruals

The timing of when a company's income and expenses are recorded in its books is the primary distinction between cash accounting and accrual accounting. These two methods of accounting differ in a number of other respects as well. Businesses that are able to use cash accounting almost always choose to do so because it is less complicated and more straight forward than other accounting methods.

Because income and expenses are recorded at different times if a business is using cash or accrual accounting, this also impacts when businesses incur tax liability (or benefit) as a result of these transactions. This is because cash accounting records income and expenses immediately, while accrual accounting records them at the end of the accounting period.

For instance, businesses that use cash accounting have a tax liability as soon as the funds from a sale hit their account, whereas businesses that use accrual accounting are taxed on sales made in a given year, regardless of whether or not those sales have been paid for. This is because accrual accounting measures revenue as it is earned.

Cash basis accounting has both advantages and disadvantages.

Accounting on a cash basis is a method in which revenue is recorded at the time that the cash is actually received, and in the same way, expenses are recorded at the time that they are paid. The accounting method known as "cash accounting" does not recognise or keep track of accounts receivable or payable. Because of this, the approach is most suitable for use by smaller businesses that do not maintain an inventory.

Pros

• It reveals the amount of cash currently available. Cash accounting provides a snapshot of actual account balances and makes it simple to determine the amount of money that your company actually has at any given time. Cash accounting also makes it possible.
• It gives users a greater degree of control over transactions. The management of one's finances and one's tax situation could both benefit from this.
• Keeping tabs on one's income and expenditures is made much simpler. Keeping track of when money enters or exits your account is all that is required. You are not required to keep track of your payables or receivables (though you still should).
• There is a reduced possibility of being unable to make required tax payments. Your income won't be subject to taxation until it actually appears in your bank account.

Cons

• It does not reveal a company's liabilities in any way. Since cash basis accounting does not take into account future payables, it is difficult to determine the extent of your company's liabilities using this method.
• Not all companies would benefit from implementing this strategy. The Internal Revenue Service does not permit businesses to use cash accounting if they engage in sales on credit or have collected over $26 million in gross sales in any one of the preceding three years.
• The change from cash accounting to accrual accounting can be challenging. If cash accounting is used from the beginning, it can be challenging to switch to accrual accounting at a later date. This can result in improper management of the company's financial resources.

Accounting on an accrual basis has both advantages and disadvantages.

When using the accrual basis of accounting, income and expenses are recorded when they are incurred rather than when the money is actually received or spent. This is in contrast to the cash basis of accounting, which records transactions as they occur. The accrual basis is the method of accounting that is used most frequently, and it is required to be used by businesses that have had gross receipts of at least $26 million in any one of the preceding three years. Businesses that have had gross receipts of more than $25 million per year on average over the course of the prior three years are required to use accrual accounting.

Pros

• It makes it simple to forecast both future income and expenditures. Accounting on an accrual basis, as opposed to cash accounting, gives you a more accurate picture of how your company is doing financially. This is because you track money owed to you as well as money that has been paid into or taken out of your accounts. In other words, you track receivables and payables.
• The results are more precise than those obtained through cash basis accounting. A more complete picture of a company's financial situation can be obtained through the use of accrual accounting, which takes into account both receivables and payables.
• Depreciation can be claimed, which results in tax savings. Although companies that use accrual accounting are subject to tax liability for sales at an earlier point in time, there is a possibility that these companies can also benefit from depreciation (of particular assets) in order to reduce their overall tax burden over the course of their operations.

Cons

• It is governed by a plethora of rules and regulations. The accrual method of accounting is a more involved method than the cash method, and there are rules surrounding particular kinds of transactions. Even more specifically, there are regulations that dictate which kinds of companies are required to use accrual accounting.
• It entails a greater time commitment than cash accounting. If your business will benefit from accrual accounting (or if you are required to use it), but you do not have the time to keep the books yourself, you will most likely need to hire a dedicated accountant in order to keep up with the accounting requirements.
• It does not accurately reflect the amount of money that is currently available. Because accrual accounting calculates account balances using transactions that may or may not have been fully settled, it is possible that you do not have as much cash on hand as your records indicate you do.
• It is possible that you will be required to make tax payments on income that you have not yet received. Even if you don't receive the money for the sale for several weeks or months, any sales that you make at the end of the year will still be subject to taxation in the year that the sale was made.